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A General Introduction to Property Rights and the Environment

A presentation to Property Rights and the Environment, a student colloquium co-sponsored by the Liberty Fund and the Fraser Institute, held in Vancouver, BC, in July 2009.

When Vanessa Schneider invited me to speak at this colloquium, she asked me to help you transition from the theoretical to the applied. You were absorbed in general principles this morning – magnificent principles! The philosophical basis for property rights … the origins and economics of property rights … This is really interesting stuff, and I loved the readings. (See references at end of talk.)

But how might we make these ideas work in practice? How might we tap into John Locke or Harold Demsetz for solutions to some of the environmental problems that we face today? How might we integrate these ideas into federal or provincial policies on natural resources? It’s a challenge that I am delighted to take on.

I should let you know that this is not how I first approached these issues. I didn’t come to my environmental career with a bunch of free-market solutions in search of environmental problems. Indeed, it was the opposite. I started working on environmental problems, assuming that the solutions lay in more government – in better laws and regulations. But as I drilled down into the issues, I learned otherwise. I learned that many problems were traceable not to an absence of government but to an absence of property rights, and pricing, and markets.

After twenty-two years of research, I still appreciate the importance of governments and regulations. But I can say without reservation that property rights are the key to environmental protection.

Property rights serve many functions. In the environmental context, there are two that seem particularly important. First, property rights can provide incentives to conserve resources. And, second, they can provide tools to protect resources from outside threats. I’ll talk about this second function tomorrow. For now, I want to focus on the first function – that of incentives.

The incentive to conserve privately owned resources was a common theme in our readings. It was often contrasted with the incentive to destroy common resources.

In the beginning, Locke reminds us, all resources were common. And that was fine as long as they were plentiful. There’s no need to assign rights to plentiful resources. Locke pointed out that cattle land in the middle of America "would not be worth enclosing." David Hume made the same point about air and water. He wrote, "when there is such plenty of any thing as satisfies all the desires of men … the distinction of property is entirely lost, and everything remains in common." (In fact, these days water is increasingly scarce, and no longer suits a commons. But I’ll come to that in a minute.)

So the problem isn’t with situations of plenty. The problem is with scarcity. People have perverse incentives to overuse even the scarcest of common resources. As Armen Alchian and Harold Demsetz explained, people use common resources "in ways that ignore the full consequences of their actions." Or, as Demsetz put it, "If a person seeks to maximize the value of his communal rights, he will tend to overhunt and overwork the land because some of the costs of his doing so are borne by others." The result? "The stock of game and the richness of the soil will be diminished too quickly."

Matt Ridley described this overuse of resources in almost brutal terms. Our ancestors, he said, "extinguished their way across the planet." They butchered animals into oblivion and they razed forests. Ridley explained that this behaviour was "caused by a form of the prisoner’s dilemma."

More often, we call it "the tragedy of the commons." Garrett Hardin coined this phrase, but he certainly didn’t invent the idea. You can find the idea in Aristotle’s work. More than 2000 years ago, he wrote, "What is common to many is taken least care of, for all men regard more what is their own than what others share with them in." You can also find the idea in the New Testament. (I was amused to see that not one but two of our readings – mine and Ridley’s – began with the same quote on this subject from the Gospel According to St. John.)

Still, over the millennia, there are few who have phrased the argument as starkly as Hardin: "Freedom in a commons brings ruin to all."

And so, when land or other resources have become scarce, and more valuable, men have developed customs and laws to regulate the commons. Regulating the commons does work sometimes, especially among small, homogeneous groups. But too often, mere regulation is not effective. What is required is the establishment of private property rights.

There’s no simple definition of private property rights. As a few of our authors noted, property rights are often a bundle of rights to use a resource. For property rights to be most effective, there are a number of qualities that should be in this bundle.

First, the strongest rights are exclusive: Their holders can prevent others from using the resource. Rights, of course, are only as exclusive as they are enforceable. So enforceability is essential. And rights must be perpetual: Permanent rights encourage management decisions that ensure long-term productivity rather than short-term gain.

The strongest rights are also transferable: This enables efficient users to buy out inefficient users. The resources will end up in the hands of those who value them most, and can make the best use of them.

When clearly defined, exclusive, enforceable, perpetual, transferable rights to a resource are established, they create powerful incentives to behave responsibly. They do so because the rights holder himself will gain or lose according to his behaviour. If he makes wise choices, he’ll benefit. If he makes bad choices, he’ll suffer. The most common way of saying this is that property rights internalize the costs and the benefits of resource use.

I loved the image provided by Tom Bethell. He explained that a system of private property "ensures that people experience the consequences of their own acts." Property, he said, "surrounds us with mirrors, reflecting back upon us the consequences of our own behaviour. Both the prudent and the profligate will tend to experience their deserts."

But enough theory. I want to turn now to how this theory might be applied to preserving and protecting two increasingly scarce resources – water and fish.

Now I must say that water and fish are not really commons. Indeed, we have almost no true commons in Canada. Many resources that we think of as common are actually owned by governments. This is true of Crown land, and forests, and (in Western Canada) water and wildlife. Even resources that are held in common – such as water and wildlife in Eastern Canada – are regulated by governments.

This is true of both water and fish. In most parts of Canada, anyone taking a substantial amount of either resource needs a licence. So we have regulated these resources, but we have not yet established many property rights in them. And therein lies the problem.

Let’s start with water. Water has many characteristics of a commons. For smaller users, water is often there for the taking. In many cities, domestic use is still un-metered. Consumers can use as much as they want, whenever they want, without any financial consequences.

Even when water is metered, it’s under-priced. Users may pay a charge for treatment and delivery, but they almost never pay a charge that reflects the value, or the scarcity, of the water they use.

For larger water users, there are other parallels to a commons. In the West, larger users are governed by first-come-first-served rules. They call the allocation system "first-in-time, first-in-right." Under this system, older water users have priority over newer users. In times of shortage, they get to use their full allocation before newer users get water at all. This system locks in water uses that made sense 50 or 100 years ago. It precludes newer uses that might be of far greater value today.

Large western water users also work under use-it-or-lose-it rules. Again, this is typical of a commons. If they don’t use all of the water in their licence, someone else will get it. That gives them strong incentives to use their full allocation, even if they don’t need it.

And there’s another way in which water is like a commons. Like Hardin’s herdsmen, water users get one hundred percent of the benefit of their water use. But they bear only a tiny fraction of the cost of their water use. They share the adverse effects with everyone else.

For all these reasons, water users have no incentive to curb their use. Where water is scarce, this is a serious problem.

Southern Alberta is a perfect example. Even before this summer’s drought, river flows have been falling, and demand has been rising. A number of rivers are fully allocated – the province has stopped accepting water licence applications for several basins. But even without new licences, some of these rivers are already over-allocated. That means that the holders of more recent licences may not get their water in drier years. A number of towns are suffering from water shortages. Some are rationing water. Some are looking for new supplies.

New supplies – pipelines, dams, even desalination – may be technically feasible, but they tend to be very expensive, both economically and environmentally. It makes far more sense on both counts to reduce demand, and to shift current allocations to those who most value the water. You need two tools to accomplish this: pricing and tradable water rights.

Proper pricing sends important signals to consumers about the value and the scarcity of water. It enables them make informed decisions. It gives them incentives to consider alternative technologies and practices. And so it limits demand for water.

But there remains the question of how limited supplies are allocated. That’s where exclusive, perpetual, transferable water rights come in.

And I’m happy to say that Alberta has finally cottoned on to this. A decade ago, a new Water Act changed the nature of water rights. It changed the sticks in the bundle, if you will, making rights much stronger. Water rights would no longer be fixed to land. Licensees could trade all or part of their allocation. Transfers could be temporary or permanent.

But these new water rights are by no means fully transferable. And that’s their greatest drawback. The Water Act imposed many restrictions on water rights transfers. Transfers have to be authorized by an area’s water management plan or by an order of Cabinet. Each transfer requires an application to Alberta Environment and a public review. The government can withhold 10 percent of the water allocation in a proposed transfer.

Perhaps because of these restrictions, or perhaps because of other rules governing the largest water users (the irrigation districts), or perhaps because the system is still new, there haven’t been many transfers. Between 2003 and 2007, there were just a couple dozen.

But experience elsewhere suggests that trades will increase as the market becomes more familiar, as information on potential buyers and sellers and prices becomes more readily available, and as other transactions costs decline. Trades are also likely to become more common as water becomes scarcer, as it becomes more expensive, and as current users’ opportunity costs increase. Such conditions will strengthen incentives for water rights holders to use their allocations more efficiently. Farmers, for example, will have incentives to change their irrigation methods, or line their leaking canals, or plant crops that need less water – and then sell or lease their unused water to others.

But tradeable water rights aren’t just about creating incentives. They’re also about tapping into local knowledge. As Louis De Alessi explained, with a nod to Friedrich Hayek, "A great deal of information is local, linked to specific circumstances of time and place, and dispersed among many individuals." Terry Anderson and Donald Leal took up this same theme. Also citing Hayek, they wrote of the resource allocation problem as one of "‘how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of utilizing knowledge not given to anyone in its totality.’"

Roy Cordato noted that this fundamental problem of information "dooms all attempts at efficient central planning." And water planning is no exception. When central planners make decisions about allocating water, they do so without any knowledge of specific times or places. They do so without understanding individual preferences or subjective values. As De Alessi explained, the process of aggregation "inevitably destroys information that is place and time specific." Aggregate data is incomplete, it’s inaccurate, it’s out of date.

Compare that to the knowledge that the holders of water rights have. Only a farmer himself can know how and when he uses water, what it’s worth to him, or how he might conserve it. This seems obvious when you look at the water rights transfers that have occurred in Alberta. In some cases, the transfers have moved water from one irrigation use to another. How could a central planner possibly know which irrigation use is more valuable? A couple of the transfers moved water from irrigation to stock watering. A couple more from irrigation to municipal use. One, to lawn and garden watering; another, to a golf course. In every case, the water was moved from a lower valued use to a higher valued use. But only those directly involved could gauge what that value might be.

Unfortunately, from an environmental perspective, transfers are not moving water back into streams and rivers, regardless of how highly valued instream uses might be. Individuals and associations aren’t allowed to purchase water rights for instream flows. Only the province itself can hold a licence for conservation objectives. That’s crazy. Conservationists, recreational water users, fishermen – all have an interest in seeing more water left in certain streams. If they could acquire rights through the market, they would likely do so. That’s certainly been the experience in the western US. Water markets for instream flows were pioneered there in the late 1980s. They’ve been extremely successful.

I want to turn my attention now from water to fish – another scarce resource that would benefit immensely from the establishment of exclusive, permanent, transferable property rights. A number of our readings touched on fish.

Like Hardin, Anderson and Leal used a fishery to illustrate the tragedy of the commons: "Catching fish this year means those fish will not have an opportunity to grow larger and to reproduce, but in the open ocean a fish left for tomorrow will be caught by another fisher. Hence, each fisher ignores the future value of the fishery and overharvests today…. Taking a fish today imposes costs on all fishers tomorrow … but these costs are spread among all fishers, while the benefits redound to the individual…. If access to a valuable resource such as an ocean fishery is unrestricted, people entering the commons to capture its value will ultimately destroy it."

As I mentioned earlier, access to Canadian fisheries is rarely unrestricted. Governments have regulated them for decades. They’ve decided who gets access, for how long a season, using what kind of gear. But still, our fisheries do have many of the worst features of a commons. And the consequences have been tragic.

With fish, as with other resources, the most serious problems have resulted from perverse incentives – incentives to over-fish. These incentives certainly plague fishermen, when they don’t have exclusive, perpetual, transferable rights to the resource. But instead of focussing on that issue, I want to explore another aspect of the perverse incentives that drive overfishing. And those are the incentives of the government managers who issue licences, set catch limits, and otherwise govern the fisheries.

I want to suggest that governments cannot manage fisheries sustainably. They simply don’t have the incentives to make the best long-term decisions.

There are a number of reasons for this. First, there’s the problem of time horizons. Politicians (who guide the bureaucrats) have short perspectives. They tend to see just as far as the next election. They will do what it takes to get reelected in a year or two. Our fisheries managers frequently choose actions with short-term political pay-offs … and disastrous long-term consequences.

Next, there’s the problem of agency. In most businesses, managers act as the agents of shareholders. They act in their shareholders’ interest. But whose agents are politicians and bureaucrats? What interests do they represent? The problem is that they represent different interests that clash with one another. In Canada, the interests of commercial fishermen, recreational fishermen, aboriginal fishermen, processors, conservationists, and taxpayers conflict.

The result is often compromise that doesn’t serve anyone’s interests. Another common result is paralysis. Governments delay in the face of conflict. As one fisheries biologist explained, bureaucrats "are rewarded not for effective action, but for making every problem disappear into an endless tangle of task force meetings and reviews."

Another problem with government management is that of capture. Politicians and the bureaucrats they control are susceptible to capture by special interests. Anderson and Leal described the ways in which political resource managers respond to special interests. They noted that their rewards "depend not on maximizing net resource values, but on providing politically active constituents with what they want." In other words, government managers are susceptible to political pressure. In our fisheries, the pressure to create jobs now is the greatest political pressure of all.

Perhaps most important, when governments control fisheries, there is the problem of accountability – rewards and punishments. Government managers aren’t held accountable for the decisions they make. They don’t reap financial benefits from making good decisions. And they don’t pay the costs of making bad decisions. They don’t have financial incentives to make the best long-term decisions.

This is a point that De Alessi made several times. Government decision makers, he wrote, "do not bear the value consequences of their decisions. Thus, they have less incentive than private owners to take them into account."

I know of no better illustration of these problems inherent in government management than the East Coast cod fishery. That fishery was once one of the greatest in the world. In the 1980s, stocks began to collapse. The government closed the fishery in 1992. Only limited fishing has occurred since then. But the stocks still haven’t recovered.

The cod fishery provides a textbook case of the mismanagement of a fishery for short-term political gain. In the 1970s, Canada’s official fisheries management objective was to maximize employment. The government promised to do so even at the expense of fish. In order to create jobs, successive governments offered fishermen, boat owners, and fish processors subsidies, tax breaks, and low-interest loans. And they made Unemployment Insurance much more generous. In these ways, the government lured people into the industry. These people became dependent on the fishery. Not surprisingly, they pressured politicians to keep catch levels high. Overfishing became institutionalized.

By the early 1980s, there were signs that too many fishermen were chasing too few cod. Inshore fishermen reported falling catches and smaller fish. But the bureaucracy could not process information from thousands of small-boat fishermen, all using different gear in different ways. It couldn’t quantify or computerize it. In the words of one bureaucrat, "you just don’t want to deal with that kind of messy information."

In the mid 1980s, several studies warned that the government’s stock assessments were far too optimistic and that catch levels were far too high. But the government paid no heed. It actually raised catch limits. Finally, in 1988, it began to lower them. But it did so very slowly, over four years. Too slowly. By 1992, the cod had all but disappeared.

The fisheries minister at the time was John Crosbie. He later admitted that he had been too slow to close the fishery, and that his aim had been to keep constituents employed. In his words, there was a "tendency among politicians to put the interests of fishermen – who were voters – ahead of cod, who weren’t." The irony is that in destroying the cod fishery, the government put 40,000 fishermen and processors out of work. It created a long-term ecological, economic, and social disaster. And of course, no one was held accountable for the disaster.

Sadly, the government still hasn’t learned. Just a few weeks ago, Canadian Press reported, "Newfoundland and Labrador’s recreational cod fishery will reopen next month despite concerns that stock levels are too low to sustain it."

That’s the story of our cod fishery. Unfortunately, political mismanagement is by no means unique to that fishery or that period of time. Back in 1980, a fisheries bureaucrat published a paper on the history of fisheries management. He spelled out four kinds of questions that can be asked of a fishery: the biological question (how many fish?); the economic question (how many dollars?); the social question (how many jobs?); and the political question (how many votes?).

When resource users themselves have strong property rights in a resource, they ask the biological and economic questions. But they rarely ask the social and political questions. Their incentives are different – and far more sustainable.

Property rights to fish can take many forms. They might be geographic – a fisherman might have rights to a particular stretch of a river, or to a particular reef. For many fisheries, the most promising rights are called ITQs – individual transferable quotas. An ITQ gives a fisherman the right to a specific share of a catch. De Alessi mentioned such rights in the context of the New Zealand abalone fishery. You can also find them in Australia and Iceland – and in some Canadian and American fisheries, including that for halibut. Even so, ITQ systems are used in only about one percent of the world’s commercial fisheries.

ITQs give fishermen reasons to limit their fishing effort. Stocks, if managed properly, can sustain themselves indefinitely. When fishermen hold secure, long-term, transferable rights, they have powerful incentives to maximize the stock’s value, not just today, but in the future. They have a financial interest in conserving their stocks, in using them efficiently, in monitoring them, in enhancing them. Property rights internalize the benefits of good management. As the stocks grow, and catches become easier or larger, the value of the rights increases.

Last month, the New York Times explained this very effectively. In an editorial endorsing ITQs as the best way to end overfishing, it said, "The theory is that share-holding fishermen will have a vested interest in seeing their resource grow, much like shareholders in a company." What a refreshing approach to resource management.

I’ll be back tomorrow, with another presentation. Today I focussed on the role of property rights in creating incentives for environmental protection. Tomorrow I’ll focus on property rights as tools. I’ll look at how common-law property rights historically enabled individuals to protect the environment, and how governments have systematically weakened this institution.